The Saudi British Bank Consolidated Financial Statements For the year ended 0
CONSOLIDATED STATEMENT OF FINANCIAL POSITION As at 31 December ASSETS 2017 2016 Notes Cash and balances with SAMA 3 26,874,499 24,121,821 Due from banks and other financial institutions 4 13,490,700 8,217,746 Positive fair value derivatives 10 532,364 721,912 Investments, net 5 26,976,751 29,273,055 Loans and advances, net 6 117,006,087 120,964,815 Investment in an associate and a joint venture 7 524,924 642,297 Property and equipment, net 8 1,134,927 1,038,352 Other assets 9 1,075,092 1,075,896 Total assets 187,615,344 186,055,894 LIABILITIES AND EQUITY Liabilities Due to banks and other financial institutions 11 3,690,975 3,419,174 Customers deposits 12 140,239,513 140,639,785 Debt securities in issue 13 2,998,748 4,517,636 Borrowings 14 1,682,445 1,709,958 Negative fair value derivatives 10 481,195 604,793 Other liabilities 15 5,051,997 3,885,620 Total liabilities 154,144,873 154,776,966 Equity Equity attributable to equity holders of the Bank Share capital 16 15,000,000 15,000,000 Statutory reserve 17 9,545,984 8,557,339 Other reserves 18 488 24,052 Retained earnings 7,858,470 7,127,537 Proposed dividends 27 939,650 570,000 Total equity attributable to equity holders of the Bank 33,344,592 31,278,928 Non-controlling interest 19 125,879 - Total equity 33,470,471 31,278,928 Total liabilities and equity 187,615,344 186,055,894 Mathew Pearce David Dew Chief Financial Officer Managing Director & Authorized Member The accompanying notes 1 to 41 form an integral part of these consolidated financial statements. 1
CONSOLIDATED STATEMENT OF INCOME For the years ended 31 December 2017 2016 Notes Special commission income 21 6,051,288 6,075,102 Special commission expense 21 953,404 1,318,187 Net special commission income 5,097,884 4,756,915 Fees and commission income, net 22 1,255,534 1,340,843 Exchange income, net 431,407 478,045 Income from FVIS financial instruments - 6,994 Trading income, net 23 258,398 261,648 Dividend income 52,499 37,844 Gains on available for sale investments, net 24 30,944 26,297 Other operating income, net 242 18 Total operating income 7,126,908 6,908,604 Salaries and employee related expenses 25 1,228,591 1,228,958 Rent and premises related expenses 139,773 135,660 Depreciation 8 124,785 110,903 General and administrative expenses 697,414 608,029 Provision for credit losses, net 6 1,001,828 944,560 Impairment of other financial assets, net 5 48,855 49,540 Total operating expenses 3,241,246 3,077,650 Income from operating activities 3,885,662 3,830,954 Share in earnings of an associate and a joint venture 7 68,916 63,777 Net income 3,954,578 3,894,731 Basic and diluted earnings per share (in SAR) 26 2.64 2.60 Mathew Pearce David Dew Chief Financial Officer Managing Director & Authorized Member The accompanying notes 1 to 41 form an integral part of these consolidated financial statements. 2
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME For the years ended 31 December Notes 2017 SAR 000 2016 SAR 000 Net income 3,954,578 3,894,731 Other comprehensive income for the years items that may be reclassified subsequently to consolidated statement of income Available for sale financial assets - Net change in fair value 18 (87,156) 405,301 - Transfer to consolidated statement of income, net 18 19,056 (26,297) Cash flow hedges - Net change in fair value 18 89,927 11,326 - Transfer to consolidated statement of income, net 18 (54,276) (6,080) Total other comprehensive (loss) / income for the years (32,449) 384,250 Total comprehensive income 3,922,129 4,278,981 Mathew Pearce David Dew Chief Financial Officer Managing Director & Authorized Member The accompanying notes 1 to 41 form an integral part of these consolidated financial statements 3
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY For the years ended 31 December Attributable to equity holders of the bank Share Statutory Other Retained Proposed Noncontrolling capital reserve reserves earnings dividends Total interest Equity 2017 Notes SAR 000 SAR 000 SAR 000 SAR 000 SAR 000 SAR 000 SAR 000 SAR 000 Total Balance at the beginning of the year 15,000,000 8,557,339 24,052 7,127,537 570,000 31,278,928-31,278,928 Total comprehensive income for the year Net income for the year - - - 3,954,578-3,954,578 3,954,578 Net changes in fair value of cash flow hedges 18 - - 89,927 - - 89,927-89,927 Net changes in fair value of available for sale investments 18 - - (87,156) - - (87,156) - (87,156) Transfer to consolidated statement of income 18 - - (35,220) - - (35,220) - (35,220) (32,449) 3,954,578 3,922,129 3,922,129 Non-controlling interest arising on business combination - - - - - - 125,879 125,879 Treasury shares 18 - - 6,655 - - 6,655-6,655 Employee share plan reserve - - 2,230 - - 2,230-2,230 Transfer to statutory reserve 17-988,645 - (988,645) - - - - Zakat for the year 27 - - - (63,000) (27,000) (90,000) - (90,000) Income tax for the year 27 - - - (316,500) (131,068) (447,568) - (447,568) 2016 final dividend paid, net of zakat and income tax 27 - - - - (411,932) (411,932) - (411,932) 2017 interim dividend paid, net of zakat and income tax 27 - - - (915,850) - (915,850) - (915,850) 2017 final proposed dividend, net of zakat and income tax 27 - - - (939,650) 939,650 - - - Balance at the end of the year 15,000,000 9,545,984 488 7,858,470 939,650 33,344,592 125,879 33,470,471 2016 Balance at the beginning of the year 15,000,000 7,583,656 (340,608) 5,361,489 570,000 28,174,537-28,174,537 Total comprehensive income for the year Net income for the year - - - 3,894,731-3,894,731-3,894,731 Net changes in fair value of cash flow hedges 18 - - 11,326 - - 11,326-11,326 Net changes in fair value of available for sale investments 18 - - 405,301 - - 405,301-405,301 Transfer to consolidated statement of income 18 - - (32,377) - - (32,377) - (32,377) 384,250 3,894,731 4,278,981 4,278,981 Treasury shares 18 - - (18,357) - - (18,357) - (18,357) Employee share plan reserve - - (1,233) - - (1,233) - (1,233) Transfer to statutory reserve 17-973,683 - (973,683) - - - - 2015 Final dividend paid 27 - - - - (570,000) (570,000) - (570,000) 2016 Interim dividend paid 27 - - - (585,000) - (585,000) - (585,000) 2016 Final proposed dividend 27 - - - (570,000) 570,000 - - - Balance at the end of the year 15,000,000 8,557,339 24,052 7,127,537 570,000 31,278,928-31,278,928 Mathew Pearce David Dew Chief Financial Officer Managing Director & Authorized Member The accompanying notes 1 to 41 form an integral part of these consolidated financial statements. 4
CONSOLIDATED STATEMENT OF CASH FLOWS For the years ended 31 December OPERATING ACTIVITIES 2017 2016 Notes Net income for the year 3,954,578 3,894,731 Adjustments to reconcile net income to net cash from operating activities: Amortisation of premium on non-trading investments, net 10,150 40,192 Gains on non-trading investments, net 24 (30,944) (26,297) Depreciation 8 124,785 110,903 Income from FVIS financial instruments - (6,994) Cash flow hedge gain transfer to consolidated statement of income (54,276) (6,080) Share in earnings of an associate and a joint venture 7 (68,916) (63,777) Provision for credit losses, net 6 1,001,828 944,560 Employee share plan reserve 13,386 10,710 Impairment of other financial assets, net 5 48,855 49,540 4,999,446 4,947,488 Net (increase) decrease in operating assets: Statutory deposit with SAMA 3 691,152 203,452 Due from banks and other financial institutions with an original maturity of more than three months from date of acquisition (1,579,983) (527,223) Loans and advances, net 2,956,900 4,037,261 Other assets and derivatives 438,566 410,324 Net increase (decrease) in operating liabilities: Due to banks and other financial institutions 271,801 1,584,268 Customers deposits (373,936) (8,247,393) Other liabilities and derivatives 271,374 65,171 Net cash from operating activities 7,675,320 2,473,348 INVESTING ACTIVITIES Proceeds from sale and maturities of non-trading investments 21,177,306 73,459,574 Purchase of non-trading investments (18,443,972) (66,883,021) Purchase of property and equipment 8 (219,531) (157,800) Dividend from a joint venture 7 56,500 114,715 Acquisition of subsidiary, net of cash and cash equivalent acquired 19 84,384 - Net cash from investing activities 2,654,687 6,533,468 FINANCING ACTIVITIES Debt securities in issue 13 (1,518,888) 4,698 Borrowings (27,513) 1,662,970 Treasury shares purchased (4,500) (30,300) Dividends paid (1,642,304) (1,023,634) Net cash (used in) / from financing activities (3,193,205) 613,734 Increase in cash and cash equivalents 7,136,802 9,620,550 Cash and cash equivalents at the beginning of the year 22,958,777 13,338,227 Cash and cash equivalents at the end of the year 28 30,095,579 22,958,777 Special commission received during the year 6,069,144 5,918,030 Special commission paid during the year 1,062,816 1,283,214 Supplemental non-cash information: Net changes in fair value and transfers to consolidated statement of income (32,449) 384,250 Mathew Pearce David Dew Chief Financial Officer Managing Director & Authorized Member The accompanying notes 1 to 41 form an integral part of these consolidated financial statements. 5
1. General The Saudi British Bank ( SABB or the Bank ) is a Saudi Joint Stock Company and was established by Royal Decree No. M/4 dated 12 Safar 1398H (21 January 1978). SABB formally commenced business on 26 Rajab 1398H (1 July 1978) with the taking over of the operations of The British Bank of the Middle East in the Kingdom of Saudi Arabia. SABB operates under Commercial Registration No. 1010025779 dated 22 Dhul Qadah 1399H (13 October 1979) as a commercial bank through a network of 81 branches (2016: 84 branches) in the Kingdom of Saudi Arabia. SABB employed 3,263 staff as at (2016: 3,317). The address of SABB s head office is as follows: The Saudi British Bank P.O. Box 9084 Riyadh 11413 Kingdom of Saudi Arabia The objectives of SABB are to provide a range of banking services. SABB also provides Shariah approved products, which are approved and supervised by an independent Shariah Board established by SABB. SABB has 100% (2016:100%) ownership interest in a subsidiary, SABB Insurance Agency, a Limited Liability Company registered in the Kingdom of Saudi Arabia under commercial registration No. 1010235187 dated 18 Jumada II 1428H (3 July 2007). SABB has 98% direct and 2% indirect ownership interest in its subsidiary (the indirect ownership is held via a subsidiary registered in the Kingdom of Saudi Arabia). The principal activity of the subsidiary is to act as a sole insurance agent for SABB Takaful Company (a subsidiary company of SABB - see note 7) within the Kingdom of Saudi Arabia as per the agreement between the two subsidiaries. However, the articles of association of the subsidiary do not restrict the subsidiary from acting as an agent to any other insurance company in the Kingdom of Saudi Arabia. SABB has 100% (2016:100%) ownership interest in a subsidiary, Arabian Real Estate Company Limited, a limited liability company registered in the Kingdom of Saudi Arabia under commercial registration No. 1010188350 dated 12 Jumada I 1424H (12 July 2003). SABB has 99% direct and 1% indirect ownership interest in its subsidiary (the indirect ownership is held via a subsidiary registered in the Kingdom of Saudi Arabia). The subsidiary is engaged in the purchase, sale and lease of land and real estate for investment purposes. SABB has 100% (2016:100%) ownership interest in a subsidiary, SABB Real Estate Company Limited, a limited liability company registered in the Kingdom of Saudi Arabia under commercial registration No. 1010428580 dated 12 Safar 1436H (4 December 2014). SABB has 99.8% direct and 0.2% indirect ownership interest in its subsidiary (the indirect ownership is held via a subsidiary registered in the Kingdom of Saudi Arabia). The subsidiary s main purpose is the registration of real estate and to hold and manage collateral on behalf of the Bank. On 17 May 2017, SABB established a Special Purpose Vehicle ( SPV ) SABB Markets Limited, a wholly owned subsidiary incorporated as a limited liability company under the laws of Cayman Islands. The subsidiary will engage in derivatives trading and repo activities. The subsidiary has not yet commenced operations. SABB has 65% (2016: 32.5%) ownership interest in a subsidiary, SABB Takaful, a joint stock company registered in the Kingdom of Saudi Arabia under commercial registration No. 1010234032 dated 20 Jumad Awal 1428H (6 June 2007). SABB Takaful became a subsidiary of SABB effective 23 November 2017 (note 19). SABB Takaful s principal activity is to engage in Shariah compliant insurance activities and offer family and general Takaful products to individuals and corporates in the Kingdom. SABB had 100% (2016:100%) ownership interest in a subsidiary, SABB Securities Limited, a Saudi limited liability company formed in accordance with Capital Market Authority's Resolution No. 2007-35-7 dated 10 Jamada II 1428H (25 June 2007) and registered in the Kingdom of Saudi Arabia under Commercial Registration No. 1010235982 dated 8 Rajab 1428H (22 July 2007). On 15 June 2017, the subsidiary was liquidated. SABB has participated in three Structured Entities for the purpose of effecting syndicated loan transactions and to secure collateral rights over specific assets of the borrowers under Islamic financing structures. The entities have no other business operations. 1. Saudi Kayan Assets Leasing Company 2. Rabigh Asset Leasing Company 3. Yanbu Asset Leasing Company 6
SABB owns 50% (2016: 50%) share in each entity. SABB does not consolidate the entities as it does not have the right to variable returns from its involvement with the entities and ability to affect those returns through its power over the entities. The related underlying funding to the borrower is recorded on SABB s books. The board of directors of SABB, in its meeting dated 25 April 2017, resolved to enter into preliminary discussions with AlAwwal Bank, a bank listed in Kingdom of Saudi Arabia, to study the possibility of merging the two banks. The entry into these discussions does not mean that the merger will happen between the two banks. If the merger is agreed, it will be subject to various conditions including, without limitation, approval at the Extra Ordinary general assembly of each bank and approval of the Saudi Arabian regulatory authorities. 1.1. Basis of preparation a) Statement of compliance The consolidated financial statements of the Bank have been prepared; - in accordance with International Financial Reporting Standards (IFRS) as modified by SAMA for the accounting of zakat and income tax, which requires, adoption of all IFRSs as issued by the International Accounting Standards Board ( IASB ) except for the application of International Accounting Standard (IAS) 12 - Income Taxes and IFRIC 21 - Levies so far as these relate to zakat and income tax. As per the SAMA Circular no. 381000074519 dated April 11, 2017 and subsequent amendments through certain clarifications relating to the accounting for zakat and income tax ( SAMA Circular ), the Zakat and Income tax are to be accrued on a quarterly basis through shareholders equity under retained earnings; and - in compliance with the provisions of Banking Control Law, the Regulations for Companies in the Kingdom of Saudi Arabia and the Bank s by-laws. Further, the above SAMA Circular has also repealed the existing Accounting Standards for Commercial Banks as promulgated by SAMA. These are no longer applicable from January 1, 2017. Refer note 2(v) for the accounting policy of zakat and income tax and note 40 for the disclosure of the impact of change in the accounting policy resulting from the SAMA Circular. b) Basis of measurement These consolidated financial statements have been prepared under the historical cost convention except for the measurement at fair value of derivatives, financial assets held at fair value through income statement ( FVIS ) and available for sale. In addition, assets and liabilities that are hedged in a fair value hedging relationship are carried at fair value to the extent of the risks that are being hedged. c) Functional and presentation currency These consolidated financial statements are expressed in Saudi Arabian Riyals (SAR), rounded off to the nearest thousands, which is the functional currency of SABB. d) Presentation of consolidated financial statements The Bank presents its consolidated statement of financial position in order of liquidity. An analysis regarding recovery or settlement within 12 months after the reporting date (current) and more than 12 months after the reporting date (non current) is presented in note 33 (b). e) Basis of consolidation The consolidated financial statements comprise the financial statements of SABB and its subsidiaries (collectively referred to as the Bank ). The financial statements of the subsidiaries are prepared for the same reporting year as that of SABB, using consistent accounting policies. Subsidiaries are entities which are directly or indirectly controlled by SABB. SABB controls an entity (the investee ) over which it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Subsidiaries are consolidated from the date on which control is transferred to SABB and cease to be consolidated from the date on which the control is transferred from SABB. Intra-group transactions and balances have been eliminated upon consolidation. 7
f) Critical accounting judgements and estimates The preparation of consolidated financial statements in conformity with IFRS requires the use of certain critical accounting judgements, estimates, and assumptions that affect the reported amounts of assets and liabilities. It also requires management to exercise its judgement in the process of applying the Bank s accounting policies. Such estimates, assumptions and judgements are continually evaluated and are based on historical experience and other factors, including obtaining professional advice and expectations of future events that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. Revisions to accounting estimates are recognised in the period in which the estimate is revised and future periods. Significant areas where management has used estimates, assumptions or exercised judgements are as follows: i. Impairment losses on loans and advances Impairment methodology The Bank s policy is to create impairment allowances for impaired loans promptly and appropriately, when there is objective evidence that impairment of a loan or portfolio of loans has occurred. Loan impairment allowances represent management s best estimate of losses incurred in the loan portfolios at the consolidated statement of financial position date. Management is required to exercise judgement in making assumptions and estimates when calculating loan impairment allowances on both individually and collectively assessed loans and advances. Collective impairment allowances are subject to estimation uncertainty, in part because it is not practicable to identify losses on an individual loan basis due to the large number of individually insignificant loans in the portfolio. The estimation methods include the use of statistical analyses of historical information, supplemented with significant management judgement, to assess whether current economic and credit conditions are such that the actual level of incurred losses is likely to be greater or less than historical experience. Where changes in economic, regulatory or behavioural conditions result in the most recent trends in portfolio risk factors being not fully reflected in the models, risk factors are taken into account by adjusting the impairment allowances derived from historical loss experience. Risk factors include loan portfolio growth, product mix, unemployment rates, concentration, geographical concentrations, loan product features, economic conditions such as trends in housing markets, the level of interest rates, portfolio seasoning, account management policies and practices, changes in laws and regulations, and other influences on customer payment patterns. The methodology and the assumptions used in calculating impairment losses are reviewed regularly in the light of differences between loss estimates and actual loss experience. Losses for impaired loans are recognised when there is objective evidence that impairment of a loan or portfolio of loans has occurred. Impairment allowances that are calculated on individual loans or on groups of loans assessed collectively, are recorded as charges to the consolidated income statement and are recorded against the carrying amount of impaired loans on the consolidated Statement of Financial Position. Losses which may arise from future events are not recognised. Individually assessed loans and advances The factors considered in determining whether a loan is individually significant for the purposes of assessing impairment include the size of the loan, the number of loans in the portfolio, and the importance of the individual loan relationship, and how this is managed. Loans that meet these criteria will be individually assessed for impairment, except when volumes of defaults and losses are sufficient to justify treatment under a collective assessment methodology (see below). Loans considered as individually significant are typically to corporate and commercial customers, are for larger amounts and are managed on an individual basis. For these loans, the Bank considers on a case-by-case basis at each reporting date whether there is any objective evidence that a loan is impaired. The criteria used to make this assessment include: - known cash flow difficulties experienced by the borrower; - contractual payments of either principal or interest being past due for more than 90 days; - the probability that the borrower will enter bankruptcy or other financial realisation; - a concession granted to the borrower for economic or legal reasons relating to the borrower s financial difficulty that results in forgiveness or postponement of principal, interest or fees, where the concession is not insignificant; and 8
- there has been deterioration in the financial condition or outlook of the borrower such that its ability to repay is considered doubtful. For loans where objective evidence of impairment exists, impairment losses are determined considering the following factors: - The Bank s aggregate exposure to the customer; - the viability of the customer s business model and their capacity to trade successfully out of financial difficulties and generate sufficient cash flow to service debt obligations; - the amount and timing of expected receipts and recoveries; - the likely dividend available on liquidation or bankruptcy; - the extent of other creditors commitments ranking ahead of, or pari passu with, the bank and the likelihood of other creditors continuing to support the company; - the complexity of determining the aggregate amount and ranking of all creditor claims and the extent to which legal and insurance uncertainties are evident; - the realisable value of security (or other credit mitigants) and likelihood of successful repossession; - the likely costs of obtaining and selling collateral as part of foreclosure; - the ability of the borrower to obtain, and make payments in, the currency of the loan if not denominated in local currency; and - when available, the secondary market price of the debt. The determination of the realisable value of security is based on the market value at the time the impairment assessment is performed. The value is not adjusted for expected future changes in market prices, though adjustments are made to reflect local conditions such as forced sale discounts. Impairment losses are calculated by discounting the expected future cash flows of a loan, which includes expected future receipts of contractual interest, at the loan s original effective interest rate and comparing the resultant present value with the loan s current carrying amount. The impairment allowances on individually significant accounts are reviewed at least quarterly and more regularly when circumstances require. Collectively assessed loans and advances Impairment is assessed collectively to cover losses which have been incurred but have not yet been identified on loans subject to individual assessment or for homogeneous groups of loans that are not considered individually significant. Retail lending portfolios are generally assessed for impairment collectively as the portfolios are generally large homogeneous loan pools. The collective impairment allowance is determined after taking into account: - historical loss experience in portfolios of similar credit risk characteristics (for example, by industry sector); - the estimated period between impairment occurring and the loss being identified and evidenced by the establishment of an appropriate allowance against the individual loan; and - management s judgement as to whether current economic and credit conditions are such that the actual level of inherent losses at the reporting date is likely to be greater or less than that suggested by historical experience. The period between a loss occurring and its identification is estimated by management for each identified portfolio based on economic and market conditions, customer behaviour, portfolio management information, credit management techniques and collection and recovery experiences in the market. An estimated period may vary over time as these factors change. Statistical methods are used to determine collective impairment losses for homogeneous groups of loans not considered individually significant. Losses in these groups of loans are recorded individually when individual loans are removed from the group and written off. The methods that are used to calculate collective allowances are: - When appropriate empirical information is available, the Bank uses roll-rate methodology, which employs statistical analyses of historical data and experience of delinquency and default to reliably estimate the amount of the loans that will eventually be written off as a result of the events occurring before the reporting date but 9
which the bank is not able to identify individually. Individual loans are grouped using ranges of past due days; statistical analysis is then used to estimate the likelihood that loans in each range will progress through the various stages of delinquency and become irrecoverable. Additionally, individual loans are segmented based on their credit characteristics as described above. In applying this methodology, adjustments are made to estimate the periods of time between a loss event occurring and its discovery, for example through a missed payment, (known as the emergence period) and the period of time between discovery and write-off (known as the outcome period). Current economic conditions are also evaluated when calculating the appropriate level of allowance required to cover inherent loss. - When the portfolio size is small or when information is insufficient or not reliable enough to adopt a roll-rate methodology, the bank adopts a basic formulaic approach based on historical loss rate experience, or a discounted cash flow model. Where a basic formulaic approach is undertaken, the period between a loss event occurring and its identification is estimated by local management, and is typically between six and twelve months. The inherent loss within each portfolio is assessed on the basis of these models using historical data observations, which are updated periodically to reflect recent portfolio and economic trends. When the most recent trends arising from changes in economic, regulatory or behavioural conditions are not fully reflected in the models, they are taken into account by adjusting the impairment allowances derived from the models to reflect these changes as at the reporting date. Incurred but not yet identified impairment Individually assessed loans for which no evidence of impairment has been specifically identified on an individual basis are grouped together according to their credit risk characteristics for a collective impairment assessment. These credit risk characteristics may include country of origination, type of business involved, type of products offered, security obtained or other relevant factors. This assessment captures impairment losses that the bank has incurred as a result of events occurring before the reporting date, which the bank is not able to identify on an individual loan basis, and that can be reliably estimated. When information becomes available which identifies losses on individual loans within the group, those loans are removed from the group and assessed individually. Write-off of loans and advances Loans (and the related impairment allowance accounts) are normally written off, either partially or in full, when there is no realistic prospect of recovery. Where loans are secured, this is generally after receipt of any proceeds from the realisation of security. Where written off loans are subsequently recovered, a credit is recognised in the consolidated statement of income. Collateral and other credit enhancements held The Bank s practice is to lend on the basis of customers ability to meet their obligations out of cash flow resources rather than rely on the value of security offered. Depending on a customer s standing and the type of product, facilities may be provided without security. For other lending, a charge over collateral is obtained and considered in determining the credit decision and pricing. In the event of default, the bank may utilise the collateral as a source of repayment. Depending on its form, collateral can have a significant financial effect in mitigating our exposure to credit risk. Additionally, risk may be managed by employing other types of collateral and credit risk enhancements such as second charges, other liens and unsupported guarantees, but the valuation of such mitigants is less certain and their financial effect has not been quantified. ii. Fair value of financial instruments The Bank measures financial instruments, such as, derivatives, at fair value at each reporting date. Also, fair values of financial instruments measured at amortised cost are disclosed in Note 35 to these consolidated financial statements. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value measurement is based on the presumption that the transaction to sell the asset or transfer the liability takes place either: - In the principal market for the asset or liability, or - In the absence of a principal market, in the most advantageous market for the asset or liability 10
The principal or the most advantageous market must be accessible to by the Bank. The fair value of an asset or a liability is measured using the assumptions that market participants would use when pricing the asset or liability, assuming that market participants act in their economic best interest. A fair value measurement of a non-financial asset takes into account a market participant's ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use. The Bank uses valuation techniques that are appropriate in the circumstances and for which sufficient data are available to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs. All assets and liabilities for which fair value is measured or disclosed in the consolidated financial statements are categorized within the fair value hierarchy, described as follows, based on the lowest level input that is significant to the fair value measurement as a whole: - Level 1 - Quoted (unadjusted) market prices in active markets for identical assets or liabilities - Level 2 - Valuation techniques for which the lowest level input that is significant to the fair value measurement is directly or indirectly observable - Level 3 - Valuation techniques for which the lowest level input that is significant to the fair value measurement is unobservable For assets and liabilities that are recognised in the consolidated financial statements on a recurring basis, the Bank determines whether transfers have occurred between Levels in the hierarchy by re-assessing categorization (based on the lowest level input that is significant to the fair value measurement as a whole) at the end of each reporting period. For the purpose of fair value disclosures, the Bank has determined classes of assets and liabilities on the basis of the nature, characteristics and risks of the asset or liability and the level of the fair value hierarchy as explained above. iii. Impairment of available for sale equity investments and debt instruments The Bank exercises judgement to consider impairment on the available for sale equity investments. This includes determination of a significant or prolonged decline in the fair value below its cost. The determination of what is 'significant' or 'prolonged' requires judgement. In making this judgement, the Bank evaluates among other factors, the normal volatility in share price. In addition, the Bank considers impairment to be appropriate when there is evidence of deterioration in the financial health of the investee, industry and sector performance, changes in technology, and operational and financing cash flows. iv. Classification of held to maturity investments The Bank follows the guidance of IAS 39 when classifying non-derivative financial assets with fixed or determinable payments and fixed maturity as held to maturity. In making this judgement, the Bank evaluates its intention and ability to hold such investments to maturity. v. Classification of fair value through income statement The Bank follows criteria set in IAS 39 when classifying financial assets and liabilities to fair value through income statement. In making this judgement, the Bank evaluates its compliance with the conditions as prescribed in IAS 39. vi. Determination of control over investees The control indicators set out note 1.1 (e) are subject to management s judgements. vii. Provisions for liabilities and charges The Bank receives legal claims against it in the normal course of business. Management has made judgments as to the likelihood of any claim succeeding in making provisions. The time of concluding legal claims is uncertain, as is the amount of possible outflow of economic benefits. Timing and cost ultimately depends on the due process being followed as per law. 11
g) Going concern The Bank s management has made an assessment of the Bank s ability to continue as a going concern and is satisfied that the Bank has the resources to continue in business for the foreseeable future. Furthermore, the management is not aware of any material uncertainties that may cast significant doubt upon the Bank s ability to continue as a going concern. Therefore, the consolidated financial statements continue to be prepared on the going concern basis. 2. Summary of significant accounting policies The significant accounting policies adopted in the preparation of these consolidated financial statements are set out below. a) Changes in accounting policies The accounting policies used in the preparation of these consolidated financial statements are consistent with those used in the preparation of the annual consolidated financial statements for the year ended December 31, 2016 except for: i. the change in the accounting policy in relation to accounting for zakat and income tax as prescribed by SAMA effective 1 January 2017 (see note 1.1 a); and ii. the adoption of the following amendments to existing standard mentioned below, which had an insignificant effect/no financial impact on the consolidated financial statements of the Bank on the current year or prior year, and is not expected to have any significant effect in future years. Amendments to existing standards - Amendments to IAS 7, Statement of cash flows on disclosure initiative: Applicable for annual periods beginning on or after 1 January 2017. These amendments introduce an additional disclosure that will enable users of financial statements to evaluate changes in liabilities arising from financing activities. This amendment is part of the IASB s Disclosure Initiative, which continues to explore how financial statement disclosure can be improved. - Amendments to IFRS 12, Disclosure of Interests in Other Entities: The amendments apply retrospectively and are effective for annual periods beginning on or after 1 January 2017. The amendments clarify that the disclosure requirements in IFRS 12, other than those in paragraph B10- B16, apply to an entity s interest in a subsidiary, an associate or a joint venture (or portion of its interest in a joint venture or an associate) that is classified (or included in a disposal group that is classified) as held for sale. b) Business combinations and goodwill Business combinations are accounted for using the acquisition method. The cost of an acquisition is measured as the aggregate of the consideration transferred, which is measured at the acquisition date fair value and the amount of any non-controlling interest in the acquiree. For each business combination, the Bank elects whether to measure the non-controlling interest in the acquiree at fair value or at the proportionate share of the acquiree s identifiable net assets. Acquisition-related costs are expensed as incurred and included in general and administrative expenses. When the Bank acquires a business, it assesses the financial assets and liabilities assumed for appropriate classification and designation in accordance with the contractual terms, economic circumstances and pertinent conditions as at the acquisition date. This includes the separation of embedded derivatives in host contracts by the acquiree. Any contingent consideration to be transferred by the acquirer will be recognised at fair value at the acquisition date. All contingent consideration (except that which is classified as equity) is measured at fair value with the changes in fair value in profit or loss. Contingent consideration that is classified as equity is not remeasured and subsequent settlement is accounted for within equity. Goodwill is initially measured at cost (being the excess of the aggregate of the consideration transferred and the amount recognised for non-controlling interests) and any previous interest held, over the net identifiable assets acquired and liabilities assumed. If the fair value of the net assets acquired is in excess of the aggregate 12
consideration transferred, the Bank re-assesses whether it has correctly identified all of the assets acquired and all of the liabilities assumed and reviews the procedures used to measure the amounts to be recognised at the acquisition date. If the reassessment still results in an excess of the fair value of net assets acquired over the aggregate consideration transferred, then the gain is recognised in profit or loss. After initial recognition, goodwill is measured at cost less any accumulated impairment losses. Any goodwill arising from initial consolidation is tested for impairment at least once a year and whenever events or changes in circumstances indicate the need for impairment, they are written down if required. c) Trade date accounting All regular way purchases and sales of financial assets are recognised and derecognised on the trade date i.e. the date on which the Bank becomes a party to the contractual provisions of the instrument. Regular way purchases and sales are purchases and sales of financial assets that require delivery of assets within the time frame generally established by regulation or convention in the market place. d) Derivative financial instruments and hedge accounting Derivative financial instruments including foreign exchange contracts, special commission rate futures, forward rate agreements, currency and special commission rate swaps, currency and special commission rate options (both written and purchased), are measured at fair value (premium received for written options). All derivatives are carried at their fair value as assets where the fair value is positive and as liabilities where the fair value is negative. Fair values are generally obtained by reference to quoted market prices, discounted cash flow models or pricing models, as appropriate. The treatment of changes in their fair value depends on their classification into the following categories: i) Derivatives held for trading Any changes in the fair value of derivatives that are held for trading purposes are taken directly to the consolidated statement of income for the year. Derivatives held for trading also include those derivatives which do not qualify for hedge accounting. ii) Embedded derivatives Derivatives embedded in other financial instruments are treated as separate derivatives and recorded at fair value if their economic characteristics and risks are not closely related to those of the host contract, and the host contract is not itself held for trading or designated at fair value through income statement. The embedded derivatives separated from the host are carried at fair value in the trading derivatives portfolio with changes in fair value recognised in the consolidated statement of income. iii) Hedge accounting The Bank designates certain derivatives as hedging instruments in qualifying hedging relationships. For the purpose of hedge accounting, hedges are classified into two categories; (a) fair value hedges which hedge the exposure to changes in the fair value of a recognised asset or liability, and (b) cash flow hedges which hedge exposure to variability in cash flows that is either attributable to a particular risk associated with a recognised asset or liability, or a highly probable forecasted transaction that will affect the reported net gain or loss. In order to qualify for hedge accounting, it is required that the hedge should be expected to be highly effective i.e. the changes in fair value or cash flows of the hedging instrument should effectively offset corresponding changes in the hedged item, and should be reliably measurable. At the inception of the hedge, the risk management objective and strategy is documented including the identification of the hedging instrument, the related hedged item, the nature of risk being hedged, and how the Bank will assess the effectiveness of the hedging relationship. Subsequently, the effectiveness of the hedge is assessed on an ongoing basis. In relation to fair value hedges, which meet the criteria for hedge accounting, any gain or loss from remeasuring the hedging instruments to fair value is recognised immediately in the consolidated statement of income. The related portion of the hedged item is recognised in the consolidated statement of income. Where the fair value hedge of a special commission bearing financial instrument ceases to meet the criteria for hedge accounting, the adjustment in the carrying value is amortised to the consolidated statement of income over the remaining life of the instrument. If the hedged item is derecognised, the unamortised fair value adjustment is recognised immediately in the consolidated statement of income. 13
In relation to cash flow hedges, which meet the criteria for hedge accounting, the portion of the gain or loss on the hedging instrument that is determined to be an effective hedge is recognised in the consolidated statement of comprehensive income. The ineffective portion, if any, is recognised in the consolidated statement of income. For cash flow hedges affecting future transactions, the gains or losses recognised in other reserves are transferred to the consolidated statement of income in the same period in which the hedged transaction affects the consolidated statement of income. Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated or exercised, or no longer qualifies for hedge accounting. On discontinuation of hedge accounting on cash flow hedges any cumulative gain or loss that was recognised in other reserves, is retained in shareholders equity until the forecasted transaction occurs. Where the hedged forecasted transaction is no longer expected to occur, the net cumulative gain or loss recognised in other reserves is transferred to the consolidated statement of income for the year. e) Foreign currencies The consolidated financial statements are denominated and presented in Saudi Arabian Riyals, which is also the functional currency of the Bank. Transactions in foreign currencies are translated into Saudi Arabian Riyals at the spot exchange rates prevailing at transaction dates. Monetary assets and liabilities at year-end, denominated in foreign currencies, are translated into Saudi Arabian Riyals at the exchange rates prevailing at the reporting date. The foreign currency gain or loss on monetary items is the difference between amortised cost in the functional currency at the beginning of the year adjusted for effective interest and payments during the year, and the amortised cost in foreign currency translated at the exchange rate at the end of the year. All differences arising on non-trading activities are transferred to exchange income in the consolidated statement of income, with the exception of differences on foreign currency borrowings that provide an effective hedge against a net investment in foreign entity. Foreign exchange gains or losses on translation of monetary assets and liabilities denominated in foreign currencies are recognised in the consolidated statement of income, except for differences arising on the retranslation of available for sale equity instruments or when deferred in equity as qualifying cash flow hedges and qualifying net investment hedges to the extent hedges are effective. Translation gains or losses on non-monetary items carried at fair value are included as part of the fair value adjustment either in the consolidated statement of income or in equity depending on the underlying financial asset. f) Offsetting financial instruments Financial assets and liabilities are offset and are reported net in the consolidated statement of financial position when there is a currently legally enforceable right to set off the recognised amounts and when the Bank intends to settle on a net basis, or to realise the asset and settle the liability simultaneously. Income and expenses are not offset in the consolidated statement of income unless required or permitted by any accounting standard or interpretation, and as specifically disclosed in the accounting policies of the bank. g) Revenue/expenses recognition Special commission income and expense Special commission income and expense for all commission-bearing financial instruments is recognised in the consolidated statement of income on an effective yield basis. The effective commission rate is the rate that exactly discounts the estimated future cash payments and receipts through the expected life of the financial asset or liability (or, where appropriate, a shorter period) to the carrying amount of the financial asset or liability. When calculating the effective commission rate, the Bank estimates future cash flows considering all contractual terms of the financial instrument but not future credit losses. The carrying amount of the financial asset or financial liability is adjusted if the Bank revises its estimates of payments or receipts. The adjusted carrying amount is calculated based on the original effective commission rate and the change in carrying amount is recorded as special commission income or expense. If the recorded value of a financial asset or a group of similar financial assets has been reduced due to an impairment loss, special commission income continues to be recognised using the original effective commission rate applied to the new carrying amount. The calculation of the effective yield takes into account all contractual terms of the financial instruments (prepayment, options etc.) and includes all fees paid or received related transaction costs, and discounts or premiums that are an integral part of the effective commission rate. Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of financial asset or liability. 14
When the Bank enters into special commission rate swap to change special commission from fixed to floating (or vice versa) the amount of special commission income or expense is adjusted by the net special commission on the swap. Special commission income on Shariah approved products received but not earned is netted off against the related assets. Exchange income/ loss Exchange income/loss is recognised when earned/incurred. Dividend income Dividend income is recognised when the right to receive income is established. Fees and commission income and expenses Fees and commission income are recognised on an accrual basis when the related services have been provided. Loan commitment fees for loans that are likely to be drawn down are deferred and, together with the related direct cost are recognised as an adjustment to the effective yield on the loan. Portfolio and other management advisory and service fees are recognised based on the applicable service contract, usually on a time proportionate basis. Fees received on asset management, wealth management, financial planning, custody services and other similar services that are provided over an extended period of time are recognised over the period when the service is being provided. When a loan commitment is not expected to result in the drawdown of a loan, loan commitment fees are recognised on a straight-line basis over the commitment period. Other fees and commission expense relate mainly to transaction and service fees, which are expensed as the service is received. Any fee income received but not earned is classified under other liabilities. Net trading income Results arising from trading activities include all gains and losses from changes in fair value and related special commission income or expense, dividends from financial assets and financial liabilities held for trading and foreign exchange differences. This includes any ineffectiveness recorded in hedging transactions. Day one profit Where the transaction price differs from the fair value of other observable current market transactions in the same instrument or based on a valuation technique whose variables include only data from observable markets, the Bank immediately recognises the difference between the transaction price and fair value (a Day 1 profit) in the consolidated statement of income in Net trading income. In cases where use is made of data which is not observable, the difference between the transaction price and model value is only recognised in the consolidated statement of income when the inputs become observable, or when the instrument is derecognised. h) Sale and repurchase agreements Assets sold with a simultaneous commitment to repurchase at a specified future date (repos) continue to be recognised in the consolidated statement of financial position as the Bank retains substantially all the risks and reward of ownership and continued to be measured in accordance with related accounting policies for the underlying financial assets held as FVIS, available for sale, held to maturity and other investments held at amortised cost. The counterparty liability for amounts received under these agreements is included in due to banks and other financial institutions or customers deposits, as appropriate. The difference between sale and repurchase price is treated as special commission expense and amortised over the life of the repo agreement, using the effective yield method. Assets purchased with a corresponding commitment to resell at a specified future date (reverse repo) are not recognised in the consolidated statement of financial position, as the Bank does not obtain control over the assets. Amounts paid under these agreements are included in Cash and balances with SAMA, Due from banks and other financial institutions or Loans and advances, as appropriate. The difference between purchase and resale price is treated as special commission income and amortised over the life of the reverse repo agreement, using the effective yield method. i) Investments All investment securities are initially recognised at their fair value which represents the consideration given, including acquisition charges associated with the investment (except for investments held as FVIS, where acquisition charges are not added to the cost at initial recognition and are charged to the consolidated statement of income). Premiums are amortised and discounts accreted using the effective yield method and are taken to special commission income. 15